Volatility investors: once bitten but not shy

NEW YORK (Reuters) - Investors burned this week by the steep drop in the value of financial instruments that bet on stock market calm have a counterintuitive reaction: wade straight back in.

A trader works on the floor of the New York Stock Exchange in New York, U.S., February 7, 2018. REUTERS/Brendan Mcdermid

Many are even looking for an opportunity to buy “short volatility” again using exchange-traded products (ETPs).

Two banks, Credit Suisse Group AG (CSGN.S) and Nomura Co Ltd (9716.T), said on Tuesday they would terminate two exchange traded notes (ETN) that bet on low volatility in stock prices, including Credit Suisse’s VelocityShares Daily Inverse VIX Short-Term ETN XIV.P which will stop trading by Feb. 20.

“(Volatility-linked ETPs) are the easiest way for long portfolio managers to hedge their portfolio,” said Seth Golden, the Ocala, Florida-based president of Finom Group, who rose to fame last year after the New York Times profiled the former logistics manager for discount store retailer Target who started trading volatility products.

As long as people are looking to hedge their exposure there will be other participants willing to take on that risk, he said.

Monday’s volatility shock resulted in a 32 percent drawdown for Golden but as of Tuesday, he was only down about 16 percent, he said. Reuters was unable to independently verify the performance of Golden’s portfolio.

“I was not only able to weather the storm but also put on exposure, add to my current short position, to the level that I desire,” he said.

Across internet forums where such investors gather, and in interviews with Reuters, many volatility investors’ reactions have melded confusion, disappointment and anger over a bad trade with a continued appreciation for exchange traded notes like XIV and other similar products.

One post on Reddit came to the defense of the bank that issued the product, “CREDIT SUISSE DID NOTHING WRONG,” while another poster claimed to have lost $4 million.

Investors said that volatility will be traded whether or not ETPs exist, and that those products just offer an easy way to make those bets.

A return to normal market conditions could also revive a trade that delivered some investors a near-600 percent gain for the two years ending Feb. 1, analysts said.

“XIV has made me a lot of money, and I do see the opportunity to make more money with these types of products in the future,” said Phoenix, Arizona-based David Meyers, CEO of A La Carte Charts Inc, a social media site geared toward active investors.

Some investors said they would miss Credit Suisse’s XIV note especially because it does not result in a cumbersome extra tax document for investors, unlike some rival products.

XIV’s prospectus spelled out the risks of an investment in the ETN, saying a large decline could result in its closure, removal from the market and likely loss of all or a substantial part of the investment.

“The long term expected value of your ETNs is zero,” the prospectus says.

Scott Wetherington, the chief investment officer at Cavalier Investments LLC, said he sold his XIV stake a few weeks ago but “we likely could and would” buy another short-volatility product.

He said the termination of XIV should not have come as a shock in light of the market’s sharp movement, and that he was ready for the volatility.

“We weren’t surprised by it at all - it’s stated in the prospectus pretty clearly,” said Wetherington.

“I just don’t think people really take the time to do the due diligence.”

If investors do decide to challenge Credit Suisse over their product, it would not be the first time.

The firm was sued in 2012 by investors who owned a “leveraged” ETN after new issuance of the notes, designed to double the return of an index, were suspended. A U.S. federal appeals court in 2014 ruled in favor of the bank, saying no reasonable investor could have read disclosures for the product without understanding their risk.